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Maine Republican Susan Collins and other GOP senators are toying with what they’re calling a “carve-out” to benefit small businesses that pay their taxes through the individual side of the Tax Code.

A sort of GOP Plan B, a carve-out could give Republicans — and some red state Democrats — a way to save face if they’re faced with a choice between allowing the government to go over the fiscal cliff or swallow some sort of marginal tax rate increases.

Collins, for her part, is reprising her proposal to impose a 2 percent surtax on the wealthiest earners, with a carve-out. But the concept could also apply to a broader marginal rate increase. The idea is to exempt those profits, from S-corporations, partnerships and other passthrough entities, from the income tax increases Obama wants for top earners.

But it’s far from clear whether a carve-out would pass muster with the White House and congressional Democrats, whose official preference is a full expiration of the Bush-era rates for top earners. It would be messy and take a big chunk out of the revenue that Obama is seeking to generate from marginal rate hikes. It would also run into long-standing partisan divisions over what constitutes a “small business” — and how many of them, exactly, would be hurt by increasing upper-income tax rates.

But discussions reflect the difficult position Republicans face in the fiscal cliff talks, after an election in which Obama made the expiration of the top Bush-era tax rates a central rallying cry.

“It’s more of a break-the-glass-type proposal if we can’t get the deal we want to prevent the rates from going up,” said one senior GOP aide who has talked with several Republican offices about the idea. “There’s definitely been talks of this type of carve-out, but the hope still is that Obama and congressional Democrats will agree to the framework that Boehner and McConnell have laid out.”

Republicans have conceded that revenues will have to be put on the table, but have been pushing to avoid actual rate increases — a position shared by at least a few Democrats. Some top Democrats have discussed a rate increase short of the Clinton-era rates, while some House Republicans have signaled a willingness to raise taxes on millionaires.

Still, few Republicans are willing to budge off of their strict no-tax-rate-increase position at this stage in the fiscal cliff negotiations.

Asked whether the House Ways and Means Committee is considering a carve-out, panel spokesman Sage Eastman noted that the committee majority is still not even considering rate increases, so it’s “kind of tough to even get to the second step.”

GOP opposition to Obama’s pitch to allow rate hikes on households making more than $250,000 has focused heavily on the potential risks to small businesses. They say tax increases on the top 2 percent will crush startups, often citing an Ernst & Young study — authored by former top Treasury official Robert Carroll — that says the increases would result in more than 700,000 fewer jobs and stifle economic growth.

That’s because about 75 percent of businesses, and almost all companies classified as small businesses, file their profits individually rather than through the corporate tax code.

“The problem with raising tax rates on wealthy Americans is that more than half of them are small-business owners,” Boehner said in a press conference last week.

Democrats often counter that only about 3 percent of those small businesses would actually be affected by the rate increases, and that Republicans are hiding behind small businesses in their efforts to protect the wealthy. They say that the GOP is including in its calculations people not normally thought of as small-business entrepreneurs: celebrities who receive income from speaking engagements, people who invest in stock, best-selling authors who get royalties for book sales and partners in law firms and hedge funds.

“In reality, only a tiny fraction of the top earners actually own, control and manage a business that is small and has hired anyone,” Senate Finance Committee Chairman Max Baucus (D-Mont.) said on the Senate floor in July.

A small-business carve-out, GOP aides say, might look like one Collins introduced last December during the standoff on the payroll tax holiday.

The Maine Republican introduced legislation to extend the payroll cut and several other expiring provisions, and offset it with a 2 percent surtax on millionaires. The surtax included an exemption of sorts for businesses that had less than 500 employees.

Readers' Comments (99)

Republicans can agree to tax increases, but should do so ONLY with structural spending cuts that begin NOW, and an outline to reform Medicare, Social Security, Medicaid, and the tax code over the next 12 months. The Republicans could add in a dose of sweetener by saying that if targets are met, then they WILL agree to raise the debt ceiling.

Wait...aren't 100% of all small businesses going to benefit at least in some way (their first $250k of earnings) from the tax rate extension? Aren't 97% of all small businesses going to benefit fully (those making below $250k) from the tax rate extension? This is simply a way for the GOP to protect the super wealthy, who try to call themselves a small business person.

Yes, kdbroom. That is correct. It's a little advertised fact that everyone benefits from the tax cut up to the $250,000 mark. If you make $250,000.00 then your taxes could be safe from increase. If you make $1 Million then only the portion of your income above that $250,000 mark would be subject to the modest tax increase. And besides, isn't it the GOP who have whined and said the tax increases would affect small business because most small businesses are owned by individuals. They are so confused.

Republicans can agree to tax increases, but should do so ONLY with structural spending cuts that begin NOW, and an outline to reform Medicare, Social Security, Medicaid, and the tax code over the next 12 months. The Republicans could add in a dose of sweetener by saying that if targets are met, then they WILL agree to raise the debt ceiling.

Oood morning, tehe3.

Absolutely agree. Cut spending FIRST.

Spending is how we accumulated a $ 16 trillion+ deficit, and we're borrowing money to pay that? It's like getting a loan from the bank to pay the bank what we owe them. That is crazy! .

Typical of the Republicans to hold 97% of small businesses hostage in order to help out the top 3%.

But the Republican definition of "small business" is, shall we say, very elastic?

It includes the Bechtel Corporation, the largest engineering firm in the country. It is the fifth-largest privately owned company in the United States, posting gross revenue in 2008 of $31.4 billion. The GOP definition also includes the Wall Street buyout firm Kohlberg, Kravis and Roberts, which has more than $54 billion in assets and 14 offices around the globe. The auditing firm PricewaterhouseCoopers, which has operations in more than 150 countries, fits the bill as well.

The reason conservatives cite these companies as “small businesses” is that they are “pass-through” entities, meaning that instead of paying the corporate income tax, they “pass-through” their earnings to individual owners, who claim the profits on their personal income tax returns. There are legitimate reasons for incorporating in this fashion, but it is also a way for large companies to avoid taxes.

Tax cuts didn't create jobs, if they did, there would be more jobs -- remember, we gave the "job creators" another round of the Bush Jr tax cuts to create jobs with... After tax rates are increased on the 1% and the economy continues to recover, there will be ample evidence that the GOP is not only a losing party in the last election, their philosophy is a failure as well. Deficits! They only matter when there is a Democratic president.

Yes really crazy!!! two unfunded off the books wars, Another unfunded drug rebate program. And then take the huge surplus left by your predecessor and distribute it to all your wealthy cronies. I certainly hope some Republicans get a whiff of fresh air soon and help us turn the economy around. We really miss the days when centrist wasn't a dirty word but a way forward to find solutions. You lost get over it and come to the table with a reasonable voice or be left behind.

You are on the right path, but, as this article points out, there are numerous challenges with carve outs.

Here is another thought: get business income off the individual tax return and onto a universal business tax return. That way you tax all business income, whether earned by Exxon or Joe's Bicycle Shop the same way. Obviously, a graduated rate structure would give breaks to small businesses. Otherwise, all business income would be taxed according to the same set of rules, whether the business income is earned by a C-corp, S-corp, partnership or sole proprietorship.

This would eliminate the attempt to offset business losses against wage income and reduce the impact of the alternative minimum tax.

This is the ultimate FIX! Pleas explore it Ms. Collins. Also, your time permitting, look at my 12 point plan to completely revise the Internal Revenue Code at www.nickeldimequartertax.com. Have a wonderful day.

Carve-outs are not a good starting point, as some Republicans claim. In their slavish attempts to coddle the rich, Republicans are being too cute and clever by half. The top rate going up is not negotiable. If businesses balk at it, let them simply incorporate and pay their corporate taxes (after taking all their built-in deductions). A business that hires over 450 workers is not a small business and any businessman declaring over $250,000 in a year has enough money to pay the extra taxes. The tax code needs simplified; instead, Republicans are trying to make it more complex (so the richest can avoid the slight increase in taxes too).

The Republicans could add in a dose of sweetener by saying that if targets are met, then they WILL agree to raise the debt ceiling.

The Republicans would be offering nothing. All American patriots have to support raising the debt ceiling, since it's necessary to pay the bills Congress has already rung up. Unless, of course, Republicans are threatening to do great damage to our country simply because their political agenda is stymied.

You know what is frustrating is that these people have the data to prove what will and will not work. They are not doing the work they should.

Personally I like the cap in deductions way better than any other idea I have heard. I think that will get the really wealthy that they 'say' they want. I really think raising rates is a gimmick and will get the nicely well off but not really really rich. They will just increase their deductions and not really get hit. I think the rate hike is a gimmick that sounds good but really is being used to protect the really rich.

Mine are assumptions based on feelings but these people have the data why aren't they using it?

Tax cuts didn't create jobs, if they did, there would be more jobs -- remember, we gave the "job creators" another round of the Bush Jr tax cuts to create jobs with... After tax rates are increased on the 1% and the economy continues to recover, there will be ample evidence that the GOP is not only a losing party in the last election, their philosophy is a failure as well. Deficits! They only matter when there is a Democratic president.

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Yep!

Let's go over the fiscal cliff and let those taxes on the rich increase! The Bush tax cuts didn't help the middle class or the poor. It only benefitted the rich. So we should all support the end of those giveaways!